One of the concerns clients often express to their advisors is fear over equity market volatility. Last week’s bellicose warnings from North Korea have added to those concerns. By the end of last week, the CBOE Volatility Index (VIX) had moved up to close around 15% to 16%, after hovering around 10% over the past month.
Despite the North Korea-fueled uptick, equity market volatility is still relatively low, considering that as recently as January and February 2016, the VIX was regularly trading over 20% and reached a high of 40% the prior August. Given this, advisors should not be too complacent. There are sound reasons why volatility has been low this summer, and why this won’t necessarily last.
With So Much Political Uncertainty, How Can Volatility Be Low?
With equity volatility relatively low over the past six months, investors may be surprised given the Trump administration’s staffing turmoil and other political issues that unfolded during this period. In fact, the political soap opera may have actually distracted the market from economic news, keeping volatility in check.
We tend to see low volatility at times when market participants are focused on microeconomic influences, such as corporate earnings. This “bottom up,” fundamental-type news – good or bad – is released one company at a time over an extended period, therefore keeping broad equity market volatility low. As earnings come in, investors choose market sectors they like and invest in them, sometimes on a rotating basis. In this type of market, we don’t see short-term volatile moves in broad indexes.
For most of this year, macroeconomic factors have not been a concern or focus of market participants. Rates are set to rise, but investors expect this to happen very gradually. Another factor keeping volatility low is confidence that the regulatory environment is, and will remain, business-friendly. As we all know, individuals and companies are more open to making investments in a more favorable regulatory environment.
Volume and Seasonal Considerations
Another key reason for volatility staying in check is below-normal trading volume. Volatility and trading activity go hand in hand, and lower volume is a key market feature right now.
Market participants are sitting in equities, in part because the potential for rising rates is making them more cautious about fixed income investments. There’s not a pressing urgency to get in or out of the equities market. As mentioned, the micro-driven, measured buying is inspired by positive company fundamentals.